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Treasury and Federal Reserve Foreign Exchange Operations*

By Charles A. Coombs

Over the six-month period, August 1973-January 1974, merous occasions, but operations were required only covered by this report, the dollar recovered strongly from in five instances. These System operations, as detailed in the speculative attack that, during the first week of July, the interim report appearing in the December issue of this had driven down the dollar against the major European Review, totaled $243.3 million, of which $238.9 million currencies to as much as 20 percent below official central was drawn under the swap lines and repaid by the end of rates. This sharp depreciation of dollar rates was unwar­ October 1973. ranted by the improving United States external position From November through late January, the dollar’s re­ and threatened to magnify the impact of worldwide infla­ covery gained increasing momentum as evidence accu­ tion on price levels here in this country. The speculative mulated that the United States balance of payments was wave was abruptly broken on July 9 as reports circulated moving decisively into surplus. As United States exports of an imminent resumption of exchange operations by the soared, the trade account showed a dramatic turnaround, Federal Reserve, backed up by a major enlargement of the registering a sequence of monthly surpluses. Heavy foreign System’s reciprocal lines of credit with foreign central purchases of United States securities, foreign direct invest­ banks. Subsequent Federal Reserve intervention in support ments in the United States, and repatriations by United of the dollar during the rest of July totaled $273.4 million, States companies of buoyant overseas earnings reinforced entirely financed by drawings on the swap lines with for­ the demand for dollars. Set against the weakening pay­ eign central banks. ments positions of several major foreign countries, the These swap credits taken down by the Federal Reserve general improvement in the United States position gave during July were completely repaid by mid-August as a strong boost to confidence in the dollar. As the oil crisis dollar rates moved up. From late August through October, suddenly erupted, cutbacks in oil supplies and the succes­ the exchange markets gradually settled down to more or­ sive steep price increases by the producing nations clearly derly trading conditions, with much narrower fluctuations threatened to have far-reaching effects on industrial out­ in rates from day to day as well as during trading sessions. put and employment, price inflation, and the balance of In this improved atmosphere, the market also showed payments in the major industrialized countries. On each greater resilience in absorbing the shocks of adverse poli­ of these counts, the market took the view that the United tical and economic news here and abroad. During this pe­ States, far less dependent on imported oil than Europe and riod, the Federal Reserve stood ready to intervene on nu­ Japan, could better cope with the damaging consequences of supply restrictions and more readily absorb the pay­ ments burden of costlier oil. At the same time, it was widely anticipated that a major share of the oil producers’ higher revenues would be attracted to dollar investments. This favorable market assessment of United States pros­ * This report, covering the period August 1973 through January 1974, is the twenty-fourth in a series of reports by the Senior Vice pects triggered a strong movement of short-term funds out President in charge of the Foreign Function of the Federal Reserve of the major European currencies and the Japanese yen Bank of New York and Special Manager, System Open Market Account. The Bank acts as agent for both the Treasury and Federal into dollars. Rising dollar rates were accelerated by a large- Reserve System in the conduct of foreign exchange operations. scale unwinding of long-standing speculative positions in

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foreign currencies, and various foreign central banks sold Table I dollars from their reserves to moderate the declines of their FEDERAL RESERVE RECIPROCAL CURRENCY ARRANGEMENTS currencies. Nevertheless, by mid-January, the German In millions of dollars mark and Swiss franc had fallen by roughly 23 percent Amount of facility against the dollar from their peak levels of early July Institution February 1, 1974 1973, while other major European currencies had also de­ clined sharply. In late January, following the widespread Austrian National Bank ...... 250 dismantling of capital restrictions here and abroad, dollar National Bank of Belgium ...... 1,000 rates topped off and a declining trend developed during Bank of C anada...... 2,000 February. National Bank of D enm ark...... 250 With the dollar rising steadily on its own from Novem­ Bank of England ...... 2,000 ber through January, there was naturally no need for even Bank of France...... 2,000 temporary support operations by the System. As foreign German Federal Bank ...... 2,000 currencies came on offer, however, both the Federal Re­ Bank of Italy ...... 3.000 serve and the United States Treasury were able to make Bank of Japan ...... 2.000 further progress in repaying foreign debt left outstanding Bank of Mexico ...... 180 at the time of closure of the gold window in August 1971. Netherlands Bank ...... 500 Beginning in August 1973, the Federal Reserve resumed Bank of Norway ...... 250 modest daily purchases of Belgian francs in the market to Bank of Sweden ...... 300 repay swap drawings on the National Bank of Belgium Swiss National Bank ...... 1,400 incurred prior to August 15, 1971. By the end of January Bank for International Settlements: 1974, $128.2 million of those drawings had been repaid, Swiss francs-dollars ...... 600 leaving $261.8 million equivalent remaining (see Table II). Other authorized European currencies-dollars . 1,250

In January 1974, the System also repaid through market Total 18,980 purchases $193.8 million of Swiss franc debt incurred prior to August 15, 1971, thereby reducing the System’s total Swiss franc debt to $971.2 million. As of January 31,

therefore, System swap debt had been cut down to $1,232.9 million, compared with the peak of $3,045 mil­ Chart I lion outstanding on August 15, 1971. SELECTED EXCHANGE RATES* The Treasury also took advantage of the strengthening of the dollar to make net purchases during December 1973 and January 1974 of $186.5 million of German marks, French francs, Belgian francs, and Japanese yen, of which $132.9 million equivalent was subsequently used to pay down United States Treasury debt to the International Monetary Fund (IMF) to an end-of-January total of $1.3 billion. In addition, in October 1973 the Treasury had re­ paid at maturity the last of its German-mark-denominated securities with marks purchased from the Bundesbank. As a result, by end-January, the remaining Treasury medium- term foreign currency debt, all denominated in Swiss francs, totaled $1,587.9 million equivalent (see Table IV). Effective February 1, the swap line between the Bank of Italy and the Federal Reserve was increased from $2 billion to $3 billion. In this connection, Chairman Bums K 1973 1974 Percentage deviations of weekly averages of New York noon offered noted that increases in other lines might be considered as rates from New York noon offered rates on January 2, 1973. needed.

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GERMAN MARK Chart II GERMANY In the massive speculation against the dollar, which MOVEMENTS IN EXCHANGE RATE * Percent Percent erupted last spring and carried into early summer, the 45 45

German mark spearheaded the rise of European Com­ 40 - A - 40 munity (EC) currencies. By early July 1973, the mark 35 35 rate had been pushed to as high as $0.4525, some I \ 31 percent above its February central rate. The Federal 30 - J \ - 30 Reserve had then resumed intervention in the exchanges, 25 - J \ - 25 beginning on July 10. Such intervention initially encoun­ 20 20 ' / I > tered considerable market resistance, as a severe liquidity // |1 / 1 squeeze in Frankfurt touched off renewed heavy bidding 15 V / - i 15

for marks. By the end of July, the Federal Reserve had 10 — \J 10 i f — sold a total of $220.5 million equivalent of marks financed — / —' 5 t ___ J l by drawings under the swap arrangement with the Bundes­ Smith­ sonian 1 bank. The Bundesbank also had intervened in Frankfurt. central 0 rate __ Late in the month the Bundesbank succeeded in reliev­ -5 - 5

ing the immediate domestic liquidity squeeze and, with in­ -10 1 1 1 1 I I I I I j 1 1 -10 J FMAMJJ ASOND J F terest rates rising in the United States at the same time that 1973 1974 this country’s trade outlook was improving, the dollar began * In this and the following currency charts, movements in exchange rates are measured as percentage deviations of weekly averages of New York noon to stage a generalized recovery in the exchanges. Conse­ offered rates from the middle or central rates established under the Smithsonian agreement of December 18, 1971. quently, in early August, the mark came heavily on offer. "|" Upper and lower intervention limits established in December 1971.

As the mark rate declined, the Federal Reserve took the Upper and lower intervention limits around new central rate established on February 13, 1973 following devaluation of United States dollar. Limits opportunity to acquire marks in the market. Some $4.2 suspended on March 1, 1973. million equivalent of these balances was sold in the mar­ ket on August 7 when there was a brief run-up of the mark rate, but the decline in the rate quickly resumed. By mid-August, the Federal Reserve had repaid through market purchases the $220.5 million equivalent of swap drawings on the Bundesbank. Meanwhile, the Bundesbank and the remainder came from balances on hand. In had sold some of the dollars it had purchased during the all of these instances, however, the dollar recovered coordinated intervention of July. quickly, and the Federal Reserve was able to liquidate Over subsequent weeks, even as favorable trade and its swap drawings within a matter of days with marks balance-of-payments figures were released for the United purchased in the market. Apart from these occasions, States, new uncertainties about price trends and political exchange market conditions tended to improve and day-to- developments in this country surfaced from time to time. day fluctuations in the mark rate narrowed significantly With the dollar still vulnerable, the Federal Reserve re­ as the dollar consolidated its earlier gains. entered the market to resist excessive movements of mar­ The relative calm in the exchanges was suddenly ket rates. Thus, on August 20-21, when there was a shaken by the unexpected revaluation of the Netherlands resurgence of demand for marks ahead of the release guilder on September 15, which immediately raised ex­ of German trade figures, the Federal Reserve offered marks pectations of further central rate changes in the EC cur­ on those two days and again briefly later in the month. rency arrangement. Renewed speculative demand for In the two episodes the System sold a total of $54.5 marks appeared, pushing up the mark rate and pulling the million equivalent of marks drawn under the swap line other currencies in the EC band up in its wake. The Fed­ with the Bundesbank, while the German central bank eral Reserve stepped in, in coordination with the Bundes­ made modest purchases of dollars in Frankfurt. Then, in bank, to moderate the rise in the mark. Between Septem­ early September, just ahead of the official announcement ber 17 and 26 the Federal Reserve sold $156.7 million of United States wholesale prices for August, the dollar equivalent of German marks drawn under the swap line, again came under some pressure against the mark, and while the Bundesbank intervened in Frankfurt by buying the Federal Reserve sold $8.2 million equivalent of marks, nearly $140 million. This forceful intervention, together of which $3.9 million was drawn under the swap line with complementary action in other EC countries, effec­

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tively stemmed the speculative outburst. focus of attention in the exchange markets, the cutback By late September, the mark rate had steadied once of Arab oil deliveries was seen as threatening severe dis­ again and, with underlying trade and investment locations for the German economy. The mark’s decline flows tending to strengthen the dollar, the Federal was accelerated by the unwinding of earlier favorable leads Reserve was subsequently able to purchase sufficient and lags and the cutting-out of entrenched long positions marks to repay $86.1 million equivalent of the outstanding in marks. In occasionally very heavy dealing, the mark swap debt to the Bundesbank. In mid-October, the im­ plunged by 7 percent against the dollar in November and provement in the dollar was again temporarily interrupted a further IV\ percent by mid-December. The mark by a sharp fall in United States interest rates, the outbreak dropped also to the lower range of the EC “snake” and of war in the Mideast, and the resignation of Vice President required support during nearly all of November. Agnew. When news of the resignation hit the markets, While the cutbacks of oil to Europe were eased over the demand for marks suddenly intensified. To guard against December 22 weekend, the simultaneous doubling of oil disorderly trading conditions, the Federal Reserve made prices in the Persian Gulf, followed by even higher prices unusually large offers of marks in the New York market, on the part of Libya, sent new shock waves through the of which $21 million equivalent was sold. market. The general view was that these prices would Late in October, the market atmosphere was dramat­ jeopardize the balance-of-payments positions of all indus­ ically transformed when United States trade figures, trialized countries but that the United States would be showing an unexpectedly large $873 million surplus for in a better position than European countries to withstand September, confirmed to the market that the long-awaited the added cost. The mark, therefore, came heavily on offer turnaround in the United States trade position was clearly along with other European currencies in late December under way. The mark, in particular, came under heavy and the Bundesbank intervened in the exchanges, fairly selling pressure, and the Federal Reserve purchased suffi­ substantially on some days. Beginning in late December, cient marks to repay the remaining $91.5 million equiva­ this Bank also began to purchase marks in New York. An lent of swap debt then owed to the Bundesbank. By early initial $23.7 million purchased for Treasury account and November, when the unfolding oil crisis was becoming the $24.3 million purchased for System account in early Janu-

Table II

FEDERAL RESERVE SYSTEM DRAWINGS AND REPAYMENTS UNDER RECIPROCAL CURRENCY ARRANGEMENTS

In millions of dollars equivalent

Drawings (+ ) or repayments (—)

System swap 1973 1974 System swap Transactions with commitments on commitments on December 31,1972 January 31, 1974 III IV January

National Bank of Belgium ...... 415.0 25.0 f + 6.0 — 82.2 261.8 1 - 52.0 f+ 47.0 Bank of France ...... i - 47.0

German Federal Bank ...... |+104.6 f+435.6 f + 21.0 — 0— 104.6 1—278.9 (—177.7

Netherlands Bank ...... f+ 2.9 — 0— 1 - 2.9

Swiss National Bank ...... 570.0 5.0 -193.8 371.2

Bank for International Settlements (Swiss francs).... 600.0 600.0

Total ...... 1,585.0 f+104.6 J+488.6 f + 23.8 -193.8 1,232.9 {-134.6 {—377.8 I— 262.8

Note: Discrepancies in totals are due to rounding.

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Table i n DRAWINGS AND REPAYMENTS BY FOREIGN CENTRAL BANKS AND THE BANK FOR INTERNATIONAL SETTLEMENTS UNDER RECIPROCAL CURRENCY ARRANGEMENTS In millions of dollars

Drawings (+ ) or repayments (—) Drawings on Drawings on Banks drawing on Federal Reserve 1973 1974 Federal Reserve Federal Reserve System System outstanding System outstanding December 31,1972 January 31, 1974 1 II III IV January \ 6 \ q q Bank for International Settlements T + {+23.0 (+36.0 {+2.0 (against German marks) ...... — 0— q — 0— I t o © 1—23.0 I- 36.0 1 -2 .0

Total ...... — 0— { + 11.0 f+23.0 j+36.0 {+46.0 {+2.0 1 -11.0 (—23.0 1-36.0 1-46.0 1 -2 .0 —

ary were largely resold to the Bundesbank against dollars. to decline relative to rates abroad. Then, on January 29, Further purchases were then made to build up mark bal­ the United States Government announced the termination ances of the United States Treasury. of its controls on capital outflows. The dollar quickly came The downward momentum of the spot mark neverthe­ on offer and, since Germany’s strong trade balance and less continued, and by mid-January the rate had declined very substantial international reserves were seen as help­ to $0.3462, a further 8 percent from mid-December levels ing that country meet the added payments burden of the and its lowest level in nearly a year. At that point, it stood higher oil prices, the German mark in particular began just Vi percent above its February 1973 central rate and to rise sharply. Subsequently, the German authorities also fully 2 3 ^ percent below its peak of July 1973. relaxed many of their controls against inflows, lifting re­ The decision of the French authorities on January 19 strictions against nonresident purchases of long-term Ger­ to float the French franc independently from the other man securities and direct investments, allowing residents currencies within the EC snake caught dealers by surprise. to borrow abroad without prior official approval and re­ The German mark, which had recovered from its lowest ducing the “bardepot” deposit requirement from 50 per­ point, suddenly came on offer along with other currencies cent to 20 percent. These developments stimulated further remaining in the snake as dealers awaited the outcome of bidding for marks, and by the end of January the spot rate negotiations over the future of the EC monetary arrange­ had advanced by 4V4 percent from the lows reached ear­ ment. As this pressure persisted, even after announcement lier in the month. by EC officials that the band arrangement would be

continued on a more limited scale, this Bank again pur­ STERLING chased marks in the New York market for United States Treasury account in an effort to avoid an even further de­ Despite an abrupt slackening in the rate of growth last cline in the spot rate. These purchases raised the Treasury’s summer, the British economy remained gripped by severe net acquisitions of marks to $112.5 million, and $105.2 inflation. The government responded by providing stimulus million of the Treasury’s accumulated balances was used through fiscal policy, while seeking to decelerate the wage- in a repayment to the IMF on January 28. price spiral by moving to a longer term “Stage III” con­ Once the initial shock effects of the floating of the trol mechanism. Meanwhile, however, the willingness of French franc had passed, the market began to reappraise the trade unions to accept continuing restraint on wages the outlook for the dollar. By that time, there were reports was being undermined by the persistent run-up of prices. that the oil embargo would be lifted or that oil prices Inflationary pressures were exacerbated by external fac­ would be rolled back, leading some dealers to believe that tors. The worldwide rise in commodity prices and the sub­ the previous rush into dollars had perhaps been overdone. stantial depreciation of sterling since June 1972—to which Moreover, interest rates in the United States had begun the trade accounts had not yet responded—had seriously

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inflated Britain’s import bill and ratcheted domestic prices were worrisome, as they portended an escalation of the even higher. To help curb these pressures and to bolster inflationary pressures and a worsening of the trade balance sterling, the Bank of England had tightened monetary —already at a record deficit of <£364 million in Octo­ policy considerably. By early August, interest rates had ber. Moreover, a confrontation between labor and moved up to historic highs and the bank’s minimum lend­ government was shaping up as the coal miners, in partic­ ing rate had advanced to IIV2 percent. Partly as a means ular, dramatized their objections to the new wage guide­ of reinforcing Britain’s reserves, the authorities had also lines in mid-November by banning overtime and weekend encouraged public-sector borrowings in the Euro-currency work. With this action threatening cutbacks in electricity markets, and over $ 1 billion of these borrowings had been production and posing serious implications for the econ­ announced. Protected by London’s relatively high interest omy as a whole, market sentiment toward sterling turned rates, sterling declined less rapidly than other currencies in bearish. August, falling back from $2.50 to around $2.46 as the The Bank of England then moved to keep the money dollar generally strengthened. market firm by hiking its minimum lending rate to 13 per­ Early in September, however, the pound suffered a sud­ cent and by calling for additional special deposits. The den sell-off on growing concern over the prospects for the tighter money market conditions held sterling in line British economy and on rumors that the United Kingdom with other European currencies, but against the dollar it would allow the sterling-balance guarantees with former dropped sharply after midmonth, with renewed specula­ sterling-area countries to lapse when they expired on tive overtones, to as low as $2.30Vi by December 11. September 24. Speculation quickly fed on itself and in just The Bank of England provided increasing support for three days the pound plunged more than 7 cents, to a low the pound in the exchange market, while allowing a money of $2.38 in London on September 6. At that point the market squeeze to increase the interest cost of maintaining Bank of England stepped in with strong support, and the short positions in sterling. government announced its decision to extend the sterling As the conflict of the miners’ union and the govern­ guarantees for another six months at $2.4213, prompting ment hardened and coal supplies dwindled, the govern­ a rebound in sterling to around that level. In subsequent ment announced on December 13 a draconian electricity- weeks, trading remained nervous as the market awaited saving plan, including a three-day workweek. This was signs of progress in the final negotiations among govern­ followed by a new restrictive budget, designed to reduce ment, labor, and employers over the ultimate shape of the aggregate demand in line with production cutbacks and Stage III controls. Spot sterling, therefore, did not partici­ to improve the balance of payments. At the same time, pate in the rise in Continental currencies following the re­ valuation of the Netherlands guilder. Instead, the rate held fairly steady through early October and showed little response to the British government’s announcement of Stage III guidelines, as the market deferred judgment on the effectiveness of the new controls until the trade unions’ response could be weighed. The October 6 war in the Mideast then became the dominant factor in the exchanges. Funds were initially shifted out of dollars into sterling, attracted by the rela­ tively high interest rates available in London. As a result, sterling rose as high as $2.46 at one point in mid- October, even as the Bank of England purchased dollars to moderate the rise. Later that month, however, an­ nouncement of the huge United States trade surplus for September and of cutbacks in Arab oil production exerted a drag on sterling. But as the immediate impact of differen­ tial supply cutbacks was viewed as less damaging to the United Kingdom than to many of the industrialized coun­ tries, sterling fell off less sharply than other currencies. Nevertheless, the longer run implications for sterling of the unexpectedly steep rise in oil prices in October

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the Bank of England took further steps to curb excessive Chart IV credit expansion, introducing new reserve requirements FRANCE to supplement existing credit control arrangements. MOVEMENTS IN EXCHANGE RATE* Percent Percent Dealers saw these measures as marking an end to the 30 30

government’s long-standing commitment to rapid growth, 25 - 25 while at the same time limiting Britain’s capacity to 20 - 20 export. Even so, the attraction of continuing high interest r rates in London kept the pound near $2.31 through the 15 tr-r-wV X - 15 end of the year. 1 / \ 10 — y \ — 10 With sterling already in a vulnerable position, the 5 — I1 V ~T~ 5 doubling of oil prices in late December, potentially raising Smith- t j sonian Britain’s import bill by several billion dollars, triggered a par 0 value T sharp fall for the pound against the dollar. At first, the - 5 - 5

movement was roughly in line with the decline of other | -10 III! III II II -10 major European currencies. But, as talk spread of an early J FMAMJJ ASOND J F 1973 1974 general election to resolve the continuing confrontation * See footnote on Chart II. between labor militants and the government, sterling came ■j" Upper and lower intervention limits established in December 1971. ^ Upper and intervention limits as of February 14, 1973. Limits suspended on even more heavily on offer. In extremely tense and nervous March 2, 1973. trading especially in the aftermath of the French decision to float the franc, the spot rate plunged by January 21 to a record low of $2.15 Vi in London. This represented a drop of some 7 percent below the end-of-December level and 17% percent below the Smithsonian central rate. had gradually stiffened monetary policy. Thus, to keep Thereafter, sterling began to rally, as tax payments and pace with the escalation of interest rates in other major the massive overhang of short positions combined to pro­ centers, in early August the Bank of France raised its duce an unprecedented liquidity squeeze in the London discount rate by 1 percentage point to 9 Vi percent. Even money market. This upturn was reinforced when the an­ so, money market rates in Paris failed to match the even nouncement of the termination of United States capital higher levels reached in other financial centers, and a controls raised expectations of sizable inflows into high- subsequent liberalization of exchange controls led to some yielding sterling investments. By the end of January, the outflows of funds. The franc thus remained near the spot rate had been bid back up to $2.27, for a rise of 5Vi bottom of the EC band and required occasional central percent from the January 21 low. bank support during August and early September. The market generally considered the French trade

FRENCH FRANC surplus modest, compared with the massive trade sur­ pluses of some of France’s trading partners in the EC In the various exchange market upheavals over the snake, and the unexpected revaluation of the Dutch first seven months of 1973, the French franc had been guilder led to an outbreak of speculation over further ad­ bolstered by the solid surplus in France’s trade account justments, including a possible devaluation of the franc. as well as by occasional speculative inflows. The franc Offerings of French francs against German marks and rate had been pushed as high as $0.2626 in early July, Belgian francs—the currencies at the top of the EC band some 21 percent above its February central rate. In the —soon swelled to massive proportions, and the Bank of subsequent resumption of exchange market intervention France and other EC central banks intervened heavily in by the United States during July, the Federal Reserve support of the franc. In addition, the French authorities had sold some $47 million equivalent of francs in the hiked the discount rate to 11 percent, the highest in one market, financed by drawings under the swap line with hundred years, raised bank reserve requirements, and the Bank of France. As the dollar improved across the tightened credit ceilings, while also asking the banks to re­ board in early August, the Federal Reserve readily frain temporarily from lending French francs to nonresi­ acquired in the market sufficient francs to repay those dents. swap drawings. By September 24, these actions had blunted expecta­ As elsewhere, inflationary pressures had mounted in tions of an imminent devaluation. At the same time, the France, and to protect the franc’s position the authorities heavy intervention of the previous week had created an

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unprecedented squeeze for franc balances, raising the throughout November and early December, the franc de­ cost of financing speculative short positions in francs, and clined less steeply than the other EC currencies. Indeed, some dealers moved to cover their positions. As a result, by December, the franc was at the top of the EC band the franc edged off the bottom of the snake. The and there were moderate official sales of francs at the authorities soon lifted the restraint on lending to non­ upper limit. residents but also announced a far-reaching dismantling By mid-December, however, the market was shifting of those banking regulations adopted in March 1973 to to the view that the oil crisis might also have a disruptive deter capital inflows. The commercial banks quickly effect on the French economy. Then, the subsequent hike began to offer positive yields to nonresidents once again. of Mideast oil prices came as a severe blow and, by adding These measures provided a firmer tone to the market substantially to the prospective import bill, threatened to through late October, although there was occasional turn France’s trade position into sizable deficit. The franc moderate intervention to support the franc at the lower declined precipitously against the dollar in occasionally limit of the EC band. Then, as the dollar came into wide­ heavy selling and once again dropped to the bottom spread demand after announcement of the United States of the EC band. The Bank of France intervened at first huge September trade surplus, other European currencies in other EC currencies and then also in dollars to keep were depressed even more than the franc, with the result the franc within the limits of that band. In conjunction that no further intervention was required. with these operations, this Bank began in early January In early November, the market’s focus suddenly shifted to purchase francs in New York for the United States to the potentially serious effects on European countries of Treasury, accumulating a total of $33.1 million equivalent. cutbacks of crude oil supplies from the Mideast. This The pressures on the franc nevertheless remained inter­ led to a generalized demand for dollars, but at the same mittently heavy through midmonth, and by January 18 time the market took the view that France would suffer the spot rate had fallen over 8 percent from its mid- relatively less than other European countries from the Decernber level against the dollar. differential cutbacks of oil deliveries. Additional anti- On January 19, the French authorities announced that inflationary measures by the French authorities, including France would withdraw from the EC currency arrange­ selective price controls and some tightening of both ment and allow the franc to float independently for six monetary and fiscal policies, also buoyed the franc. Thus, months, explaining that prospects of a massive oil-induced while dropping progressively lower against the dollar deterioration in their balance of payments made immediate

Table IV UNITED STATES TREASURY SECURITIES FOREIGN CURRENCY SERIES In millions of dollars equivalent

Issues (+ ) or redemptions (—)

Amount 1973 1974 Amount Issued to outstanding outstanding December 31,1972 January 31, 1974 1 II III IV January

German Federal Bank ...... 306.0 -1 5 3 .0 —172.4 —0—

Swiss National Bank ...... 1,232.9 +63.6 +127.3 1,587.9

Bank for International Settlements* ...... 170.9 -6 2 .2 -127.3 —0—

f+63.6 Total ...... 1,709.8 -1 5 3 .0 —0— -1 7 2 .4 J-bl27.3 1,587.9 1-62.2 1-127.3

Note: Valuation changes account for numerical discrepancies, as well as for different dollar values in the third quarter 1973 which involved refinancing by the Swiss National Bank of a Swiss-franc-denominated security held by the Bank for International Settlements. • Denominated in Swiss francs.

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action necessary to protect French reserves and employ­ Chart V ment. The French authorities simultaneously moved to SWITZERLAND protect the currency by banning franc loans to nonresi­ MOVEMENTS IN EXCHANGE RATE * Percent Percent dents once again and by adjusting other banking regula­ 40 40 tions. The decision to float independently came as a shock 35 - - 35 to the market. Consequently, when trading resumed on Monday, January 21, the franc came under selling pres­ 30 - 1 \ - 30 sure, and the Bank of France stepped in to support the 25 - y s / V - 25 rate through dollar sales. The pressure nevertheless was 20 - ^ ^ J- 20 such that the franc dropped by about 6 percent to $0.1894 in Paris. Over subsequent days, trading remained excep­ 15 - / \j ~ 15 tionally nervous, and the Bank of France continued to in­ 10 - / - 10

tervene to moderate rate movements, not only in Paris 5 5 but also in New York through the agency of the Federal Smith­ i / f sonian o central Reserve Bank of New York. rate -5 * '" * ! II! Ill II II 1 -5 Late in January, the franc was bolstered by reports of J FMAMJJ ASOND J F an imminent $1.5 billion Euro-dollar borrowing by the 1973 1974 •)* See footnote on Chart II. French government, along with other borrowings being "(" Upper and lower intervention limits established in December 1971. arranged abroad by official French institutions, since these F Intervention limits suspended on January 23, 1973. borrowings were seen as reinforcing reserves for future support of the exchange rate. The franc then joined in the general advance of European exchange rates against the dollar following the termination of United States capital controls, and the Bank of France bought modest amounts balanced conditions in the Swiss money market at least of dollars, again partly through this Bank, to moderate for the time being. Against this background, the Swiss the rise. By the end of January the spot franc had ad­ franc traded narrowly, with only modest fluctuations vanced 4Vi percent from its low of the previous week. at the time of the guilder revaluation in September and again at the outbreak of the Mideast war. The author­ ities took advantage of these improved market conditions SWISS FRANC to reduce to zero the 2 percent per quarter negative inter­ In midsummer of last year the Swiss banking system est charge on excess nonresident Swiss franc balances and was relatively liquid despite the restrictive monetary policy to lift the restriction that the banks maintain balanced introduced in 1972. As a result, when the dollar strength­ foreign exchange positions on a daily basis. But even such ened across the board in early August, the Swiss franc a substantial relaxation of controls had only a transitory declined more rapidly than many other currencies. Once impact on the market. the dollar’s advance was established, entrenched long During this period of relatively quiet trading from positions in francs began to be unwound, adding to the late August through mid-October, the Swiss franc, while immediate demand for dollars. By August 23, the spot holding steady against the dollar, was losing some further franc had dropped 13 Vi percent against the dollar from ground against the German mark. The cumulative, adverse its July peak level of $0.3774 while also depreciating 3 shift in Switzerland’s terms of trade threatened to boost percent against the currency of its principal trading part­ the already disturbing rate of domestic inflation. More­ ner, Germany. over, the authorities were becoming concerned about the Exchange trading then turned quieter, and the Swiss quickening pace of credit expansion since the summer. franc joined in the general firming of European exchange Thus, when in late October the release of strong United rates against the dollar later in August and in early States trade figures for September touched off a vigorous September. Concern also arose early in September over advance of dollar rates throughout Europe, the Swiss possible liquidity pressures at the quarter end, but the Swiss authorities took advantage of their room to maneuver to National Bank announced that it again stood ready to tighten monetary policy. Accordingly, the National Bank provide assistance through short-dated swaps (of which raised minimum reserve requirements on foreign funds by it ultimately did $900 million). As a result, dealers felt 25 percent, while imposing a 10 percent marginal reserve reassured that the authorities were intent on maintaining requirement on domestic Swiss franc and foreign cur­

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rency time deposits above March 1972 levels. In addition, nounced on January 29, prompting a further sharp rise in the requirement that a fraction of foreign capital issues in the Swiss franc, along with other European currencies. Switzerland be converted at the central bank was reim­ For their part, the Swiss authorities also eased controls posed with a conversion ratio of 10 percent. These mea­ further, lifting the prohibition on foreign purchases of sures, together with the market’s assessment that the Swiss Swiss securities. At the end of January, the Swiss franc economy was less vulnerable than most of Europe to the traded at $0.3060, up 5 percent from its early-January low immediate effects of oil-production cutbacks, contributed and IIV2 percent above its Smithsonian central rate. to the strengthening of the Swiss franc against the other

European currencies. Consequently, even as the franc fell BELGIAN FRANC by some 6 percent against the dollar in the five weeks to November 23, it advanced more than 3 percent against the The continuing demand for Belgian exports, while main­ German mark as some dealers switched funds out of marks taining Belgium’s already strong trade position, exerted and into Swiss francs. increasing pressure on productive capacity, thereby con­ The franc moved more nearly in line with other Euro­ tributing to the buildup of inflationary pressures in the pean currencies until early December, when liquidity con­ Belgian economy. To contain these pressures, the National ditions in Switzerland tightened as banks began to seek Bank of Belgium, in early August, began to tighten its funds for normal end-of-year requirements. Since the monetary policy by raising its discount rate and limit­ National Bank, in an attempt to keep a tight rein on do­ ing access to central bank credit. Initially, these actions mestic monetary expansion, provided only part of the brought Belgian interest rates more in line with other EC banks’ needs through dollar swaps and a temporary re­ interest rates, and the Belgian franc thus held in the lease of minimum reserves, the Swiss banks turned to the middle of the EC snake as the joint float moved down exchange market. At first they sold dollars forward in or­ against the dollar. Taking advantage of the improvement der to leave their spot positions intact at a time when the in the dollar rate, the Federal Reserve acquired sufficient dollar was strengthening sharply against all other cur­ francs to repay in full the $6 million of swap debt in Bel­ rencies. But, as the year-end approached, the scramble for gian francs incurred during the July support operations. funds became unexpectedly heavy and spilled over into the When, in late August and early September, Belgian inter­ spot market. Thus, while other European currencies began est rates again fell behind rising rates elsewhere and capi­ to decline sharply against the dollar in late December, the tal outflows from Belgium resumed, the commercial rate Swiss franc held relatively firm. Once trading for the year-end was completed, however, the Swiss franc also came under heavy selling pressure, falling more than 7 percent against the dollar by early January, and the Swiss National Bank occasionally sold dollars to moderate the decline. Moreover, as the Swiss Chart VI BELGIUM franc declined, the Federal Reserve began a program of MOVEMENTS IN EXCHANGE RATE * Percent Percent regular purchases of Swiss francs in the market, using the 30 francs to repay remaining indebtedness to the National 25 - Bank incurred prior to August 15, 1971. Over the next K\ / _. three weeks, the System thereby repaid a total of $193.8 20 - million equivalent of swap commitments, reducing its 15 - T r / \ - overall Swiss franc indebtedness to $971.2 million equiva­ 10 lent. Meanwhile, the Swiss authorities sought to avoid an “ f N imminent liquidity squeeze by canceling the recall of 5 Smith­ - - sonian , minimum reserves that had been delayed at the end of central the year and by reducing required reserves another 20 rate -5 percent. The Swiss banks nevertheless remained ex­ -1 0 1.1..1.....1 1 1 1...1 I..... 1 tremely cautious as the month end approached and began to bid for francs, with the result that interest rates 1973 1974 * See footnote on Chart II. in Switzerland and on Euro-Swiss francs started to ad­ "f Upper and lower intervention limits established in December 1971. vance. The franc was thus on a firming trend when the ^ Upper and lower intervention limits around new central rate established on February 14, 1973. Limits suspended on March 1, 1973. termination of United States capital controls was an­

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settled to the bottom of the IV2 percent Benelux band, the market, the Dutch guilder weakened. As a result, some where it was supported against the Netherlands guilder, intervention was required to maintain the Benelux ar­ and to the lower range of the EC arrangement. Mean­ rangement. By mid-December the commercial rate had while, the Federal Reserve began to purchase small fallen lOVi percent against the dollar from its October amounts of Belgian francs on a daily basis to cover re­ highs, and it subsequently eased below its February 1973 maining pre-August 15, 1971 swap commitments to the Na­ central rate. tional Bank of Belgium. By mid-September, the System Toward the turn of the year, when the oil price hikes had repaid $43 million of this debt, reducing remaining shifted the focus of market attention from supply to price, commitments to $347 million equivalent. the effect on the Belgian payments position was judged to Following the September 15 revaluation of the Dutch be relatively severe. The franc therefore came on offer, guilder, the Belgian franc became a target of speculation, weakening against the dollar as well as against some other as the market focused on the close link between the two EC currencies during the last week of December. Effec­ currencies and noted that Belgium, like the Netherlands, tive January 1, the Belgian authorities removed again the had a sizable current-account surplus. The commercial V4 percent per week charge on excess nonresident franc rate was quickly pushed to the top of the EC and Benelux holdings. The Belgian franc then moved up within the EC bands, and substantial official sales of Belgian francs band until the floating of the French franc led to a new against both French francs and Dutch guilders were dip in the Belgian franc, both against the dollar and with­ needed to hold the rate within its upper intervention limits. in the snake. During the month this Bank purchased It also rose against the dollar, reaching $0.027800, some francs in the market on behalf of the United States Trea­ 12 percent above the February 1973 central rate. sury. A total of $36.2 million equivalent of francs was The Belgian authorities announced that they would not acquired, of which $23 million was used in a repayment revalue the franc and acted to curb speculative inflows by to the IMF. reimposing the XA percent per week charge on excess Late in January, in the wake of the termination of nonresident franc holdings, imposed in March but removed United States capital controls, the Belgian authorities lifted in early September, and by requesting the banks to cut the prohibition of interest payments to nonresidents and their foreign liability positions by 25 percent. These firm abolished the 100 percent marginal reserve requirement measures broke the speculative wave, and by mid-October, on nonresident accounts. These actions were expected to as relative interest incentives had again turned against induce inflows into Belgium, and the Belgian franc firmed Belgium, the Belgian franc had begun to ease against the to $0.023800 by the month end, some 43A percent above dollar while settling back to trade near the bottom of the its January low and 4 percent below its February 1973 Benelux band and in the middle of the EC joint float. centra] rate. The Federal Reserve, therefore, resumed its purchases of

Belgian francs and by early November repaid a further NETHERLANDS GUILDER $85.2 million equivalent of swap indebtedness, reducing outstanding debt to $261.8 million equivalent. As with most other industrial countries the Nether­ When the dollar strengthened against the European lands had suffered an upsurge of inflation, but real eco­ currencies in late October following announcement of the nomic growth remained sluggish during much of the year. large United States September trade surplus, the Belgian Lagging domestic demand had contributed to a widening franc declined more gradually than other EC currencies. of the already sizable current-account surplus in the The relative strength of the franc reflected a sudden tight­ Dutch payments balance but, at the same time, had ening of liquidity in Brussels which was later reinforced constrained the authorities from using monetary policy in by successive increases in the National Bank of Belgium’s an all-out fight against inflation. Consequently, interest discount rate to 7% percent. Thus, as the entire EC bloc rates remained lower in the Netherlands than in most of its of currencies dropped sharply against the dollar in No­ major trading partners, and outflows of interest-sensitive vember with the unfolding of the oil crisis, the commercial funds exerted a strong drag on the guilder in the exchanges. franc held briefly near the top of both the EC and the The spot rate moved in line with other EC currencies Benelux bands, requiring moderate official sales of Belgian against the dollar but held at or near the bottom of the francs against marks and Dutch guilders to maintain the 2Va percent EC band in the late spring and early summer. prescribed limits. Thereafter, the commercial franc re­ The guilder had also peaked against the dollar in early mained near the middle of the EC band when, with con­ July, at $0.4000, some 163/4 percent above its February cern over the differential oil supply cutbacks weighing on 1973 central rate.

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central rate and near the middle of the EC band. Chart VII By late September the Amsterdam money market was NETHERLANDS MOVEMENTS IN EXCHANGE RATE * tightening substantially, partly on seasonal factors, and Percent ______Percent interest rates were rising sharply. As the liquidity squeeze 35 intensified, the Netherlands Bank moved to relieve some 30 - — of the pressure by selling guilders spot in the exchange 25 - I\f\ / \ - market while simultaneously repurchasing them forward.

20 - / \ — Despite substantial swap assistance, however, the Dutch banks remained short of liquidity and, early in October, 15 / 1 ^ . J— Tf /\ a / ' the guilder was driven once again to the top of the EC 10 — / — ------* Y — band, where moderate daily intervention was required. — 5 On October 15 the Netherlands Bank announced a further t ~ Smith- i sonian «—^ i - increase in its discount rate to 7 percent, and pressure on central rate the guilder at the top of the EC band intensified. Then, _5 t"T III 1 1 I II II 1 J FMAMJJ ASOND J F as rumors began to circulate that the guilder would again 1973 1974 ♦ See footnote on Chart II. be revalued, intervention under the EC arrangement "t" Upper and lower intervention limits established in December 1971. grew even more substantial. Against the dollar, the spot t Upper and lower intervention limits around new central rate established on February 14, 1973. Limits suspended on March 1, 1973. rate rose to as high as $0.4081, over 13 percent above its September central rate. On October 23, along with heavy intervention in EC currencies, the Netherlands Bank also began to purchase substantial amounts of spot dollars to curb the rise of the guilder. This inter­ vention had a useful effect, and the Federal Reserve, By late summer, however, the employment picture had after consultation with the Netherlands Bank, followed brightened somewhat, and the improved domestic situation up by offering guilders in New York, selling $2.9 million allowed the Dutch authorities to employ some monetary equivalent drawn under the swap line with the Dutch restraint in an effort to curb inflation. The Netherlands central bank. Over subsequent days, the guilder joined Bank accordingly introduced liquidity ratios for the com­ other currencies in dropping sharply against the dollar mercial banks in mid-July and progressively raised its in response to news of the huge United States September discount rate, with the result that by early August Dutch trade surplus. As the spot guilder fell, the Federal Reserve interest rates had moved up into line with rates in other acquired in the market sufficient guilders to repay its swap major centers. As the outflow of interest-sensitive funds commitment. slowed, the guilder became more buoyant in the exchanges. By early November the market’s attention shifted to Although the guilder followed the general decline of Euro­ the vast new uncertainties associated with the oil crisis. pean currencies against the dollar in early August, it now Although the Netherlands was the only EC country faced moved to the top of both the EC and the Benelux bands, with a total Mideast oil embargo, there was little overt requiring occasional moderate intervention at the upper exchange market reaction until early November. Then, limits of those bands by early September. the ban on Sunday driving in the Netherlands high­ On September 15 the Dutch authorities announced lighted the potentially grave consequences of the embargo that the guilder wTould be revalued by 5 percent vis-a-vis to the Dutch economy. The guilder came on offer, special drawing rights (SDRs) as part of a package of dropping sharply against the dollar and falling to the measures aimed at curbing domestic inflation and stimulat­ bottom of both the EC and the Benelux bands. This pres­ ing employment. This action caught the market by sur­ sure continued through succeeding weeks, and by early prise and was followed by substantial speculative flows December the spot rate had plunged some 13 percent into German marks and Belgian francs and out of French from its October highs against the dollar to trade below francs—and out of dollars as well—to hedge against the its new central rate. At the same time, the Netherlands risk of further exchange rate adjustments within the EC Bank and other EC central banks were obliged to intervene snake. Concerted central bank action soon helped quell forcefully in support of the guilder at the lower limits of these fears and, after trading erratically for several days the snake. This sizable intervention, which contributed to when the guilder required support in the Benelux band, it a further tightening of the Amsterdam money market, settled at around $0.3930, 9 lA percent above its new helped check the speculative pressures, and the spot rate

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began to recover in mid-December. The guilder then came basic lending rates to a uniform 6 V2 percent and by unify­ off the bottom of the EC band, leaving room for the Neth­ ing the system of penalty rates on repeated commercial erlands Bank to provide money market relief by further bank borrowing at the central bank. Trading then quieted, dollar swaps and by easing commercial bank access to and the lira held steady through mid-October. central bank credit. The war in the Mideast and the subsequently an­ Following the doubling of Arab oil prices late in Decem­ nounced cutbacks of oil supplies provoked a new burst ber, the guilder joined in the general decline of European of import demand, largely reflecting a precautionary currencies against the dollar, falling to $0.3367, 6% buildup of inventories of petroleum products and other percent below its central rate, before leveling off. By mid- raw materials. Consequently, the lira once again came January, the immediate concern over the energy situation under selling pressure and the rate began to ease. The drop in the Netherlands had eased and the guilder declined in the lira gained momentum with announcement of the more gradually than other EC currencies. In the aftermath huge United States trade surplus for September. Growing of the floating of the French franc, the Dutch authorities awareness of the seriousness of the oil situation with regard agreed with the remaining EC participants to maintain the first to quantity and then to prices soon triggered an across- snake arrangement. At first the guilder dipped against the the-board decline for the lira as well as other European dollar, but it soon began to recover. In reaction to the lift­ currencies. By mid-November, the lira’s decline began to ing of United States controls on capital outflows later in outpace those for other European currencies as the build­ the month, the recovery gathered pace. At that time, the up of consumer-goods imports and the impact of higher Dutch authorities took the opportunity to eliminate the oil prices caused a further deterioration in Italy’s trade separate exchange market for purchases of Dutch secu­ position. By early December, in progressively heavier rities, the so-called obligation guilder. By the end of Janu­ trading, the commercial rate had plummeted roughly 8 ary the guilder had advanced to $0.3470, just 3 V2 per­ percent from late-October levels to a little more than 5 cent below its central rate. percent below the Smithsonian level. The Bank of Italy intervened heavily to resist the erosion of the rate. By mid-December, selling pressures eased off somewhat al­ ITALIAN LIRA though the market remained nervous and uncertain. By midsummer 1973, a sharp recovery of Italian business activity, rising domestic inflation, and speculation in the commodity markets had swollen Italy’s imports and seriously weakened the trade position. To bolster the lira in the face of heavy demand for foreign currencies, the authorities had reaffirmed their intention to provide sup­ port for the floating commercial rate, and had reinforced their reserves with new foreign borrowings by public enterprises, while also negotiating increased short-term credit facilities. In addition, the new coalition government had announced strong measures to come to grips with inflation, including a ninety-day price freeze, selective credit ceilings on the banks, and new exchange controls. The market responded favorably to these official initiatives, and in August, when other European currencies were weakening against the dollar, the lira was on an upswing, reaching as high as $0.001773 or some 3 percent above its Smithsonian central rate. In September the lira’s improvement faltered as a result of a further widening of Italy’s trade deficit and concern over the outlook for the domestic economy after the temporary price freeze would expire. The Bank of Italy again intervened in support of the lira while repaying most of the remaining dollar swaps it had with the commercial banks. In addition, it tightened monetary policy by raising

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In view of Italy’s already substantial trade deficit, the Chart IX doubling of Persian Gulf oil prices in late December was JAPAN seen as a further severe blow to Italy’s payments position, MOVEMENTS IN EXCHANGE RATE* Percent Percent and the lira came heavily on offer again in late December 25 25 and early January. Against this unsettled background, the 20 - - 20 French decision to pull out of the EC snake arrangement, as the Italian authorities had done eleven months before, 15 - - 15 was a further shock to the market. Along with the newly 10 - 10

floating French franc, the lira immediately began to drop 5 5 t___ ^ I J- precipitously. By January 23, the commercial lira had Smith­ -t sonian o central plunged to as low as $0.001480, a decline of nearly 10 rate -5 1 1 fl II III II \ -5 percent since the beginning of the year and fully 14 per­ JFMAMJJ ASOND J F cent below the Smithsonian central rate. The Bank of 1973 1974 * See footnote on Chart II. Italy continued to intervene in support of the lira, and f Upper and lower intervention limits established in December 1971. late in January additional Euro-dollar borrowings by ^ Intervention limits suspended on February 14, 1973, Italian public enterprises were announced, raising the total of such borrowings since mid-1972 to over $6 billion. Following the termination of United States capital con­ trols, the lira joined in the general advance of European currencies against the dollar, recovering by almost 3 per­ the pressure on official reserves continued into October. cent to a level IIV2 percent below its Smithsonian central Later that month, the cutbacks of oil supplies and the rate. At the end of January, the Bank of Italy and the sharp increases in posted oil prices announced by Mideast­ Federal Reserve agreed on an increase in their reciprocal ern countries intensified selling pressure on the yen. With swap arrangement from $2 billion to $3 billion, effective over 70 percent of its total energy requirements met by February 1. imported oil, the Japanese economy was seen as particu­ larly vulnerable to the energy crisis. As selling pressure on

JAPANESE YEN the yen built up, the Bank of Japan allowed the rate to de­ cline in several steps to about ¥ 280 by mid-November. When the Japanese yen was floated in February 1973, The Japanese authorities also began to shift the pattern of it quickly jumped up to some 20 percent above its capital controls, banning Japanese purchases of short-dated Smithsonian level. Starting in March, however, and foreign assets and relaxing certain capital inflow controls, continuing through the spring and summer, the yen came and cut back their program of lending dollars for import on offer in the exchanges as importers and exporters un­ financing. Speculation over a possible further fall in the wound earlier leads and lags of payments in favor of the yen continued to build up, however. The Bank of Japan yen. Various measures to encourage capital outflows taken provided firm support to maintain the ¥ 280 level through in the previous year led to a strong growth of direct and the rest of November and December, with the result that portfolio investments abroad and of Japanese banks’ for­ official reserves declined by a further $2.5 billion over the eign lending. At the same time, Japan’s massive trade sur­ fourth quarter. In addition, in December, the authorities plus was shrinking. The rapid expansion of the Japanese further tightened restraints on capital outflows and, to con­ economy stimulated strong import demand for raw mate­ tain domestic inflation, increased the Bank of Japan’s dis­ rials and industrial commodities, while the worldwide es­ count rate by a full 2 percentage points to 9 percent while calation of commodity prices further magnified the coun­ cutting budgeted increases in government expenditures. try’s total import bill. The result was a persistent demand The late-December announcement of a doubling in the for dollars, which was met by regular intervention by the price of Persian Gulf crude oil set off an even greater Bank of Japan around the ¥ 265 level. Consequently, wave of selling pressure against the yen. After a deter­ Japan’s reserves fell by $4 billion from early March to the mined effort to hold the spot rate, on January 7 the Bank end of July and declined a further $375 million through of Japan suspended its support of the ¥ 280 level and the September. The Bank of Japan then began to permit some yen dropped to ¥ 300, a 7 percent fallback almost to pre­ easing in the spot rate. But, as the market became increas­ float levels. To encourage inflows and discourage outflows ingly aware of the underlying weakening in the Japanese of funds, the Ministry of Finance announced liberalized payments position, adverse leads and lags developed and rules for prepayments of Japanese exports, a relaxation of

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regulations on foreign borrowings by domestic companies, new restrictions on foreign-currency bank loans to resi­ dents, used mainly for financing outward direct invest­ ments, and new constraints on Japanese purchases of for­ eign securities. The selling of yen moderated in response to these measures, but the Bank of Japan still had to in­ tervene regularly to keep the rate from going beyond the ¥ 300 level. In the wake of the French decision to float the franc, the Japanese authorities closed the Tokyo market for two days, during which the yen fell as much as 25/s percent in New York. They nevertheless decided to hold firm at ¥ 300, and when trading resumed in Tokyo, on January 23, the Bank of Japan sold a massive amount of dollars at that level. After the close in Tokyo that day the yen again declined in foreign markets. Following consulta­ tions between United States and Japanese authorities, this Bank began to bid for yen in the New York market to bring the yen rate back to near the Bank of Japan’s inter­ cial authorities. In late October, as Canadian banks sought vention level. These purchases, on behalf of the United funds for their end-of-fiscal-year needs, the influx of funds States Treasury, totaled $4.3 million equivalent and were accelerated. Consequently, the spot rate moved up to as subsequently used for a United States repayment to the high as $1.003/4, while the forward rate was simulta­ IMF. By the end of January the market was in better bal­ neously driven to a discount for the first time since August ance, with the yen having moved away from the interven­ 1972. Once the banks met their needs, the money market tion rate. But Japanese reserves had declined by a further turned more liquid and the Canadian dollar rate edged $680 million in January, or by a total of $7Vi billion since down to the $1.00 level by early November. the floating of the yen in February 1973. Through most of December the Canadian dollar held steady against the United States dollar. Consequently, it appreciated sharply against major European currencies, on CANADIAN DOLLAR the market’s view that Canada’s relative self-sufficiency in With Canada’s underlying balance of payments remain­ oil would protect the Canadian balance of payments from ing in small surplus during the late summer of 1973, both supply shortages and higher costs. movements in the Canadian dollar rate were mainly By the turn of the year the market had taken an even influenced by interest-sensitive flows of funds. The Ca­ more bullish view of the Canadian dollar’s near-term nadian authorities, while careful not to brake the expansion prospects. Again, this partly reflected the expectation that of the domestic economy, had moved interest rates higher, Canada would weather the oil price increases better than with the Bank of Canada’s discount rate reaching IV4 other major countries. Moreover, the continued worldwide percent in September. The gradual rise in Canadian market rush into raw materials and other commodities was ex­ interest rates nevertheless had lagged behind earlier sharp pected to improve Canada’s terms of trade and overall rate increases in the United States and elsewhere, and the trade position even further. In addition, a bunching of resulting outflows of funds tended to depress the spot long-term foreign issues by Canadian borrowers strength­ Canadian dollar. Strikes on the Canadian railways and in ened current and potential demand for Canadian dollars, some export industries also raised concern in the market, while the downturn of United States interest rates after and the spot rate eased from about $1.00 in early August mid-January, with Canadian interest rates steady, stimu­ to just below $0.99 by mid-September, with the Bank of lated short-term inflows to Canada as well. Consequently, Canada providing support. the Canadian dollar appreciated sharply against all major Later that month, a sharp decline in interest rates in foreign currencies and advanced to $1.01 Va by the month the United States, with rates in Canada holding steady, end, with the Bank of Canada intervening to moderate the led to a squeezing-out of the adverse interest differentials rise. Canadian official reserves increased by $85 million in and stimulated some reflows into Canada. Moreover, there January after little net change in the closing months of were sizable new foreign borrowings by Canadian provin­ 1973.

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EURO-DOLLAR encouraged by their governments to seek external credit. As investors remained reluctant to acquire fixed-interest The substantial improvement in the United States securities in view of escalating world inflation and con­ balance of payments and the marked erosion in the pay­ tinued wide fluctuations in short-term interest rates, only ments position of major foreign countries began to gener­ a small fraction of all borrowers’ needs was met through ate a significant shift in the flow of funds through inter­ public offerings in the Euro-bond market. Instead, a larger national capital markets late last summer and early fall. and growing portion was financed through privately placed As the dollar strengthened in the exchanges, earlier bor­ medium-term Euro-dollar loans, on which interest rates rowings to finance speculative sales of dollars were repaid would be adjusted periodically to reflect changes in the and dollars purchased against foreign currencies were lending banks’ cost of funds. placed in short-term Euro-dollar deposits. Meanwhile, as Late in the year, the steep increases in world oil prices primary goods prices again shot up sharply, a large por­ prompted a far-reaching reassessment of how the radically tion of the increased dollar receipts of commodity pro­ altered balance-of-payments prospects for the producing ducers was invested in the Euro-dollar market. On the de­ and consuming nations would affect the Euro-dollar mar­ mand side of the market, in addition to the normal corpo­ ket. On the one hand, it was widely expected that the rate borrowers, public entities of both industrialized and producing nations would channel a significant portion of developing nations appeared increasingly as borrowers, their higher revenues into the market. On the other hand, governments of oil-consuming countries indicated their intention increasingly to tap the market for funds to cushion their reserves. Although the market remained generally receptive to the expanding needs of public as Chart XI INTEREST RATES IN THE UNITED STATES, C A N A D A , well as private borrowers, some new loans met investor A N D THE EU RO -DO LLAR M AR KET resistance. ent THREE-MONTH MATURITIES* Perc Meanwhile, in response to the dollar’s strong improve­ ment in the exchanges, the governments of Germany and most other Continental countries had begun to relax their restraints on capital inflows. Effective January 1, the United States joined in this progressive easing of controls by re­ ducing the interest equalization tax from Vi percent to V4 percent, liberalizing the foreign direct investment pro­ gram and raising bank lending ceilings under the Federal Chart XII SELECTED INTEREST RATES Reserve’s voluntary foreign credit restraint program. Then, THREE-MONTH MATURITIES* effective January 29, these control programs were termi­ nated altogether, and other governments quickly responded by speeding up their own relaxation of controls. During the period under review, Euro-dollar rates on three-month maturities moved more closely in line with United States domestic interest rates than with rates in the major European markets. At the same time, interest differentials between comparable Euro-dollar and United States deposit instruments narrowed significantly, except at the year-end when normal seasonal positioning in the Euro-dollar market provided a temporary buoyancy for Euro-dollar rates. Thus, by the end of January, three- month Euro-dollars and United States certificates of de­ posit were both quoted just slightly above 8 Vi percent; 1973 * Weakly averagos of daily rates. late last summer, by comparison, the rates were at about HVi percent and IOV2 percent, respectively.

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The Business Situation

Economic activity apparently declined early in 1974. Meanwhile, inflation has intensified. Based on re­ Much of this weakness can be attributed to the effects vised data, the gross national product (GNP) deflator of the Arab oil embargo which, while weighing very climbed at an 8.8 percent annual rate in the fourth quarter heavily on particular sectors, has had widespread ramifi­ of 1973, up from the original estimate of 7.9 percent.1 Led cations. Industrial production fell in January for the by soaring food and energy costs, prices at both the whole­ second consecutive month, with reductions in energy sale and retail levels advanced along a broad front in and auto output accounting for about half of the total January. January contraction and all of the December decline.

Sales of new domestic-type passenger cars slumped INDUSTRIAL PRODUCTION, ORDERS, somewhat further in February to the slowest pace in AND INVENTORIES three and one-half years. Personal income also dropped significantly in January, partly as a result of reduced The Federal Reserve Board’s index of industrial produc­ employment in several key sectors and a widespread tion declined at a 9 Vi percent seasonally adjusted annual shortening of the workweek. A substantial portion of the rate in January after falling at a 7 !/2 percent pace in the rise in unemployment during recent months can be traced to previous month. By way of perspective, industrial output the direct and indirect consequences of the energy shortage. had climbed rapidly into early 1973, rising more than 12 There are, however, some tentatively encouraging signs. percent over the year ended February 1973 (see Chart I). Residential construction activity perked up somewhat in As the year wore on, a noticeable slowing in production January, as housing starts rose from the 3 Vi-year low of growth emerged; output rose at a 4.4 percent annual rate the month before and newly issued building permits also during the February-November interval, when a wide increased. In addition, retail sales registered a sizable variety of capacity limitations and shortages held the rate increase in January. New orders for durable goods rose of increase in check. The declines of December and Janu­ nearly 5 percent in January, after dropping more than ary bear the unmistakable imprint of the Arab oil embargo. 6 percent during the previous month, and the backlog Cutbacks in automotive production and energy output of unfilled orders continued to climb. Recent evidence sug­ accounted for all of the reduction in December and half of gests that business capital spending plans for 1974 may the January dip. have strengthened in the face of the energy shortage. Passenger car assemblies fell 16 percent in January to A special survey conducted by McGraw-Hill projects a large a seasonally adjusted annual rate of 6.9 million units, the 18 percent increase in capital outlays. Inventory accumu­ slowest pace since late 1970 when auto output was de­ lation has been rapid and, while extraordinary price in­ pressed by the strike at General Motors. Current produc­ creases have greatly inflated book values, a substantial amount of real inventory accumulation has been taking place. The accelerated pace of physical accumulation apparently represents investment that is intended by 1 The estimate of fourth-quarter current-dollar GNP growth has business, with the exception of the automotive sector been revised upward from $29.5 billion to $33 billion. Investment where a substantial buildup of unsold large cars occurred in business inventories was raised from a $15.9 billion to an $18 billion rate. Net exports were also raised significantly. On late last year. Even here, though, inventories seemed to be the other hand, consumption spending turned out to be even moving toward a somewhat more balanced condition in weaker than first indicated, with outlays up by only $9.2 billion. In real terms, GNP is now estimated to have grown at a 1.6 percent February since new domestic auto sales once again out­ annual rate in the fourth quarter, compared with the initial esti­ paced assemblies. mate of 1.3 percent.

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tion is symptomatic of the continuing low overall level of auto sales and the exceptionally high stocks of unsold large cars held by retail dealers. Moreover, production has been somewhat constrained because the industry is cur­ rently undergoing a major retooling process in an effort to increase production of the very popular smaller cars. Preliminary data suggest that passenger car output de­ creased modestly further in February. The energy component of industrial production, which includes refined petroleum products, electric power, and gas utilities, dropped at a seasonally adjusted annual rate of 9Vi percent in January after falling at a 42 percent annual rate in December. In January, energy production was off nearly 3 percent from its year-earlier level. It is interesting to note that the nation’s output of energy peaked last July and began to decline somewhat before the start of the Arab oil embargo. The most recent drop continues to reflect a shortage of petroleum which is related to the embargo, as well as conservation measures taken by residential and industrial users, and the abnor­ mally mild weather which covered much of the nation during the last half of January. On the other hand, the extraction of coal—the most abundant energy source in the United States—jumped very sharply in January. Since the imposition of the Arab oil embargo, the attrac­ tiveness of coal as an alternate source of energy has increased substantially. Several utilities along the Eastern Seaboard have been granted permission to burn coal to bolster production in the near future. instead of residual oil, which is in short supply. However, There is recent evidence that capital spending plans the index of coal output tends to be quite volatile on a for 1974 have strengthened even further. A special sur­ month-to-month basis, and the rise early this year only vey conducted by McGraw-Hill during late January served to return coal output to the approximate level and early February indicated that businesses are planning reached in several months of 1973. to raise their plant and equipment outlays by 18 percent New orders placed with manufacturers of durable goods in 1974. This is substantially above the increases of 12 jumped nearly 5 percent in January, on a seasonally percent to 14 percent previously projected for this year on adjusted basis, after a drop of more than 6 percent during the basis of surveys conducted in late 1973 by McGraw- the previous month. Any assessment of the underlying sit­ Hill, Lionel D. Edie, and the Commerce Department. uation is complicated by the fact that the flow of bookings Moreover, the most recent information suggests that the has been particularly volatile during the recent past. For net effect of the energy situation on capital spending may example, new orders declined during each month of the be positive, even though some sectors have substantially third quarter, but rose substantially over the next two pared their spending plans. months. On balance, the overall flow of new orders has Business inventory spending continued its rapid rise remained sizable, with orders in January about 1.3 on a book value basis in December, increasing at a sea­ percent above the June-July 1973 average. During January, sonally adjusted annual rate of $32 billion after the record a large rise of $1 billion in the very volatile defense shattering $39 billion November rise. As a result, the orders series was partially offset by a $0.6 billion drop in expansion in total business inventories during the final primary metal bookings. After declining in December, quarter of 1973 amounted to $32 billion at an annual rate, orders for nondefense capital goods rose $0.4 billion in easily the largest quarterly gain in business inventories January to a level 5.1 percent above the mid-1973 pace. since the end of World War II. Meanwhile, the backlog of unfilled orders continued to Some of the recent climb in inventories represents the swell in January, and the very large backlog should serve undesired buildup of unsold large cars. During both Octo­

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ber and November, the dollar value of inventories at retail Chart II automotive outlets jumped an average of $6 billion (sea­ RETAIL SALES sonally adjusted annual rate), but this slowed significantly Seasonally adjusted Billions of dollars Billions of dollars to a $ m billion rate of accumulation in December. By the end of January the number of new cars in the hands of dealers had, on a seasonally adjusted basis, been reduced somewhat from the levels reached during the final months of last year. Relative to sales, however, they still remained very high. Preliminary data for February indicate that the seasonally adjusted pace of domestic-type passenger car assemblies was again below that of new car sales, suggesting that a further decline in auto inven­ tories may have taken place. Also it is true that much of the rapid climb in the book value of inventories reflects the extraordinary rates of inflation experienced recently rather than the growth of physical stocks. Nonetheless, a substantial buildup of physical stocks also took place outside the automotive sector toward the end of 1973. As shown in the GNP accounts, the fourth- quarter change in real business inventories—excluding the very large rise in automotive dealers’ stocks—was three times as large as the average increase over the first three quarters of the year. Much of this stepped- Source: United States Department of Commerce, Bureau of the Census. up spending appears to have been deliberate. For example, approximately half of the unusually steep December climb in the book value of durables manufacturers’ inventories consisted of increased holdings of materials and supplies. This was very likely an intentional response to the wide­ spread shortages of materials that plagued firms during much of the recent past. of tropical storm Agnes, while the earlier drop followed a The ratio of inventories to sales for all businesses rose big lump sum social security payment. Some of the from 1.41 in November to 1.45 in December, largely as a weakness evident in January can be traced to higher social result of the drop in auto sales together with the buildup insurance contributions which are deducted from personal in auto inventories. Although the December ratio was the income. Much of the recent decline, though, is indicative highest in 1973, it was still lower than at any time during of the weakening in economic activity. This is seen most the 1968-72 period. Moreover, when the automobile clearly in the behavior of wage and salary disbursements. sector is excluded, the inventory-sales ratio was lower in Wage and salary payments dropped $2.7 billion in January December than in some earlier months of the year, sug­ after having added an average of $5.7 billion to personal gesting that most inventories remain lean relative to sales income during each of the preceding twelve months. The volume. January decline was concentrated in manufacturing and construction, where falling employment and shortened workweeks reduced wage and salary payments by $3.5 PERSONAL INCOME, CONSUMER DEMAND, billion and $1.1 billion, respectively. Farm income also AND RESIDENTIAL CONSTUCTION declined by a substantial $2.8 billion as a result of lower Personal income declined $4.1 billion in January to a subsidy payments under the Agriculture and Consumer seasonally adjusted annual rate of $1,084.9 billion. This Protection Act of 1973. was the first decline in nineteen months and the largest According to the preliminary estimate, retail sales in drop since July 1971, when income plunged by $10.1 January climbed a sizable 2.5 percent above the depressed billion. However, both of these earlier declines reflected December level (see Chart II). The January rise in mainly once-and-for-all developments. In June 1972, current-dollar sales was the largest in seven months and personal income fell mostly because of the aftereffects seemed to be fairly broad based. If this advance estimate

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holds up under subsequent revisions, the nominal value PRICES of retail sales will have climbed slightly above the peak reached last November. However, in real terms, retail sales Inflation continued to intensify during January, as sea­ remain well below the peak level measured last March. sonally adjusted wholesale prices rose at a sizzling 38 Sales of new domestic-type passenger automobiles percent annual rate. Although the rise was only about one slipped a bit further in February to a seasonally adjusted half the size of the enormous post-freeze surge registered annual rate of 7.4 million units from January’s depressed last August, it was still the second largest monthly 7.7 million unit pace. During the past several months, increase in wholesale prices in more than a quarter century, sales of domestic autos have receded to the lowest level underscoring the severity of the current inflation. since the last quarter of 1970, when a strike at General Perhaps the most distressing feature of the January Motors drastically reduced the available supply of do­ advance in wholesale prices was its pervasiveness. Prices mestic passenger cars. It may be too early to tell whether of farm products, processed foods, and feeds jumped at a the decline in auto sales, which began with the intro­ 61 percent annual rate after declining in three of the four duction of the 1974 models and continued with the previous months. Over the year ended in January, these start of the oil embargo, has just about run its course. prices rose by almost 30 percent. The resurgence of food However, sales should rise as production shifts yield price pressures is mainly attributable to rising prices of increased supplies of the popular small vehicles. wheat and beef. The realization that stocks of wheat are Residential construction activity picked up somewhat at low levels has helped push wheat prices up. Beef prices in January, as housing starts rose 6.1 percent to a season­ have increased in response to forces set in motion last ally adjusted annual rate of 1.49 million units in compari­ summer. At that time, farmers reduced the volume of son with 1.40 million units started in December. While cattle placed on feed for winter marketing in reaction to the January pace was still 40 percent below the 2.47 the price ceilings placed on beef. Ceilings were lifted million units started one year earlier, the increase may September 10, but this was too late to affect measurably mark the end of the pronounced downtrend that began in the supplies currently coming to market. the middle of last year. The recent behavior of building Meanwhile, fuel and power prices leaped 82 percent at permits also provides some encouragement: newly issued an annual rate in January, mainly because of a huge permits jumped 9Vi percent in January to the highest rate in several months. The availability of mortgage money has been enhanced by the flow of funds to mutual savings banks and savings and loan associations. Deposit growth

at these institutions, which are the major sources of mort­ Chart III gage lending, has strengthened considerably after taper­ C H A N G E S IN C O N S U M E R PRICES ing off dramatically during the summer months. According Seasonally adjusted annual rates to preliminary data, seasonally adjusted net deposit inflows were at an annual rate of about 12 percent in January, the fastest pace since the same month a year ago. There is also some indication that inflows remained strong during February. During December, shipments of mobile homes, which in recent years have represented a substantial portion of the supply of new housing, were at a seasonally adjusted annual rate of 466,000 units, about equal to the average number of shipments over the last several months. None­ theless, current shipments are sharply below the record level of 737,000 units sold in March 1973. Sales of new single-family homes also fell sharply in December to the slowest pace in three and one-half years, while inventories of unsold homes have shown little change. Consequently, the ratio of unsold homes to sales rose to a Period ended January 1974 1 month | 13 months |m |l2 months record 12.8 months of sales, almost twice the level re­ corded in the year-earlier period. Source: United States Department of Labor, Bureau of Labor Statistic

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increase in the price of crude petroleum (over 260 per­ early days of the Korean war. Advances in the prices of cent at an annual rate). Since the start of the Arab oil em­ food and energy contributed substantially to the overall bargo last October, wholesale fuel and power prices increase in consumer prices in January and in the last have risen at an annual rate of 172 percent, compared with several months. When these two components were ex­ the rise of 25 percent in the year preceding the boycott. cluded from the index, the consumer price index rose at While energy price increases dominated the overall indus­ an annual rate of 4.5 percent in January and at the same trial commodities index, other industrial prices also climbed rate during the last three months. Over the preceding very rapidly. Excluding the fuel and power component, year the index rose at a 5.1 percent annual rate. wholesale prices of industrial commodities rose at a 22 Consumer power and fuel prices continued to soar, percent annual rate in January, the largest one-month rise rising at an annual rate of 66 percent in January. This on record. Over the twelve months ended in January, such component, which includes gasoline, home heating oil, and prices increased 11 percent. gas and electricity, has increased more than 50 percent Consumer prices surged ahead at a 12 Vi percent sea­ (annual rate) since the start of the oil embargo last Octo­ sonally adjusted annual rate in January (see Chart III) ber. At the same time, food prices rose at an annual rate of after rising at a 6Vi percent pace in December. Except for 19 percent in January. This brought the rise over the past the burst last August associated with the lifting of the year to 20 percent. Based on recent estimates made by the second price freeze on most foods, this was the largest United States Department of Agriculture, food prices are month-to-month increase in consumer prices since the expected to advance substantially in the near future.

Fifty-ninth Annual Report

The Federal Reserve Bank of New York has published its fifty-ninth Annual Report, re­ viewing major economic and financial developments and the Bank’s operations in 1973. The Report observed that “inflation reemerged as the paramount economic problem in the United States in 1973, exploding with a force not seen since the early days of the Korean war”. With regard to monetary policy, the Report said that “the Federal Reserve pursued a policy of active restraint in 1973”, while at the same time the monetary authorities “sought to avoid extreme pressures on financial markets which could seriously disrupt credit flows and ulti­ mately risk generating a substantial contraction in economic activity”. Although the interna­ tional financial system experienced considerable stress during the first half of 1973, the Re­ port noted that “the fact that the central banks were prepared to intervene to prevent the reemer­ gence of disorderly conditions contributed to a much calmer atmosphere in the markets” during the remainder of the year. In his letter presenting the Report to the member banks, Alfred Hayes, President of the Bank, stated that “we must seek to reduce inflationary pressures and to reverse the escalation of cost and price increases. Both the reconstruction of the international monetary system and the restoration of confidence in the dollar depend heavily on the resumption of a reasonable de­ gree of price stability in the United States”. Mr. Hayes added that “we must, at the same time, seek to encourage sustainable economic growth .... Progress toward these objectives calls for the determined, coordinated efforts of monetary and fiscal polices.” The Annual Report may be requested from the Public Information Department, Federal Reserve Bank of New York, 33 Liberty Street, New York, N.Y. 10045. A copy is being mailed to Monthly Review subscribers.

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The Money and Bond Markets in February

Interest rates fell considerably in early February, but adjusted plus currency outside commercial banks—grew sharp yield increases toward the end of the month erased substantially in the first three statement weeks of Febru­ much of the earlier declines. In the money market, down­ ary following the decline experienced in January. Time ward pressure on rates emerged as market participants and savings deposits at commercial banks, other than large observed a greater availability of reserves in the banking negotiable certificates of deposit (CDs), apparently grew system early in the month and projected a further easing at a fairly rapid rate over the first three weeks of February of monetary policy. Although revisions of these projections as well. Consequently, the broad money supply (M 2)— caused some rates to rise toward the close of the month, plus consumer-type time and savings accounts at commer­ the rate on four- to six-month commercial paper dropped cial banks—rose sharply. However, the adjusted bank 50 basis points over the course of the month, while the credit proxy, which includes all deposits of member banks average effective rate on Federal funds fell 68 basis points plus certain nondeposit liabilities, appears to have experi­ below its January average. These declines were accom­ enced a slight decline in the three-statement-week interval panied by three V* percentage point reductions in the ended February 20, as increases in private deposits were commercial bank prime lending rate on loans to large offset by a fairly large decline in Government balances at business borrowers. As a result, the prime rate closed commercial banks. the month at 83A percent, its lowest level since July 30, 1973. Early in the month the easing of money market condi­ THE MONEY MARKET, BANK RESERVES, AND THE MONETARY AGGREGATES tions provided a firm undertone for the Government securities market, and the rally which began late in Jan­ Rates on most money market instruments continued to uary gathered strength. Treasury bill rates and yields fall sharply early in February but then rose somewhat over on intermediate-term coupon issues dropped sharply in the remainder of the month (see Chart I ) . For the month as the first statement week of the month, and the Treasury’s a whole, the effective rate on Federal funds averaged 8.97 refunding operation was highly successful. The down­ percent, 68 basis points below January’s average and its ward movement of long-term rates was more restrained, lowest level since June 1973. The bid rate on bankers’ accep­ however, as investors remained concerned about the tances closed the month at 8 Vs percent, down from a level future course of inflation and the longer run outlook of 8% percent at the end of January. In the commercial for interest rates. The rally subsequently faded in the wake paper market, rate declines on directly placed and dealer- of Chairman Burns’s Congressional testimony which was placed paper ranged from 25 to 75 basis points. In line interpreted as indicating that the apparent easing of mone­ with the drop in other money market rates, most major tary policy would not be pushed further. Near the end of the commercial banks reduced their prime lending rates to month, market participants began to press their accumu­ large business borrowers in three XA percentage point steps lated positions on the market and yields rose. Long-term to 83A percent. Member bank borrowings from the Federal corporate and municipal bond yields also rose. Over the Reserve System, however, edged upward in February (see month, the Federal Reserve Board’s index of yields on Table I), after declining over the five preceding months. newly issued Aaa-rated utility bonds increased 4 basis According to available data, both M 1 and M2 rose points to 8.30 percent and The Bond Buyer index of rapidly in the first three statement weeks of February, municipal bond yields rose 6 basis points to 5.26 percent. but the bank credit proxy declined slightly. Since short-run Available data suggest that the seasonally adjusted changes in these monetary aggregates are often influenced narrow money supply (Ma)—private demand deposits by random unpredictable movements that belie underlying

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Chart I

SELECTED INTEREST RATES December 1973 - February 1974 percent MONEY MARKET RATES BOND MARKET YIELDS Percent

1973 1974 1973 1974

Note: Data are shown for business days only.

MONEY MARKET RATES QUOTED: Bid rates for three-month Euro-dollors in London; offering standard Aaa-rated bond of at least twenty years’ maturity; daily averages of rates (quoted in terms of rate of discount) on 90- to 119-day prime commercial poper yields on seasoned Aaa-rated corporate bonds; daily averages of yields on long; quoted by three of the five dealers that report their rates, or the midpoint of the range term Government securities (bonds due or callable in ten years or more) and quoted if no consensus is available; the effective rate on Federal funds (the rate most on Government securities due in three to five years, computed on the basis of representative of the transactions executed); closing bid rates (quoted in terms of rate of closing bid prices; Thursday averages of yields on twenty seasoned twenty-year discount) on newest outstanding three-month Treasury bills. tax-exempt bonds (carrying Moody's ratings of Aaa, Aa, A , and Baa).

BOND MARKET YIELDS QUOTED: Yields on new Aao-rated public u tility bonds are based Sources: Federal Reserve Bank of New York, Board of G overnors of the Federal on prices asked by underwriting syndicates, adjusted to make them equivalent to a Reserve System, Moody’s Investors Service, Inc., and The Bond Buyer.

trends, it is useful to consider the behavior of the monetary instrument. The offering rate on three-month CDs in aggregates within a longer run perspective. Over the last the secondary market declined 80 basis points to 8.07 year the growth of M1? for example, has slowed appreciably. percent by the end of February despite some increase Seasonally adjusted daily average Mx from the four-week in the rate toward the close of the month. On a sea­ interval ended mid-February 1973 to the four-week inter­ sonally adjusted annual basis, CDs grew at the rapid val ended February 20, 1974 rose 5.4 percent (see rate of 40.1 percent in the four statement weeks ended Chart II). This represents a 3 percentage point decelera­ February 20, compared with the preceding four-statement- tion in Mi growth from that experienced over the pre­ week period. From December 12, when the marginal ceding year. During the same period, the rate of change reserve requirement on CDs was lowered to 8 percent, of M2 fell 1.6 percent from its rate of growth in the through February 20, CDs grew at a seasonally adjusted preceding year to 8.7 percent. annual rate of about 29 percent, compared with the sea­ With short-term interest rates declining, banks re­ sonally adjusted decline of CDs outstanding at virtually duced offering rates on large negotiable CDs and still the same rate while the 11 percent marginal reserve attracted a substantial volume of funds through this requirement was in effect from September 19 through

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December 12. Despite this resurgence of CD growth, the Table I increase of the adjusted bank credit proxy has remained FACTORS TENDING TO INCREASE OR DECREASE moderate, with its recent growth inhibited by the rundown MEMBER BANK RESERVES, FEBRUARY 1974 In millions of dollars; (+) denotes increase of Government deposits at commercial banks. Relative to and (—) decrease in excess reserves its four-week average level in the period ended thirteen weeks earlier, the proxy grew at a seasonally adjusted Changes in daily averages— annual rate of 6.5 percent over the four-week interval week ended Net Factors changes ended February 20. This is an acceleration from the rate of Feb. Feb. Feb. Feb. increase experienced by the proxy in the preceding 6 13 20 27 thirteen-week interval, but it is well below the growth rates of the proxy experienced in early 1973. “ Market” factors

Member bank required reserves ...... + 529 + 303 — 221 4- 625 4-1,236 Operating transactions (subtotal) ...... - f 212 — 633 — 492 4- 655 — 258 THE GOVERNMENT SECURITIES MARKET Federal Reserve f lo a t...... + 36 + 100 + 18 4- 131 4- 285 As February began, a major rally was in progress in the Treasury operations* ...... + 30 — 325 + 599 - f 189 -f 493 market for United States Treasury obligations. The rally Gold and foreign account ...... + 188 - f 50 — 71 + 67 - f 234 Currency outside b a n k s ...... — I l l — 626 — 875 had been sparked in late January by signs that some easing 4- 346 —1,266 Other Federal Reserve liabilities of monetary policy was in progress. These indications were and capital ...... - f 69 - f 166 — 162 — 77 — 4 reinforced by further injections of reserves by the Federal Total “ market” factors ...... - f 741 — 330 — 713 4-1,280 4- 978 Reserve System in early February. In addition, market

sentiment was bolstered by the removal of restrictions on Direct Federal Reserve credit foreign capital flows, including the interest equalization transactions tax, and the terms of the Treasury’s February refunding. Open market operations (subtotal) ...... — 685 + 270 + 887 —1,000 — 528 The latter development was viewed positively since the Outright holdings: o Treasury announced plans to pay down about $0.5 billion Treasury secu rities...... — 482 -f 260 + 382 — 373 _i_ I Rankers' acceptances...... + 3 i x + 1 of debt. 3 + 5 Federal agency obligations ...... — 18 — 22 + 120 + 77 In this environment, rates on Treasury bills dropped Repurchase agreements: sharply during the initial statement week of the month. Treasury secu rities...... — 131 + 16 + 290 — 498 — 323 Bidding was very aggressive at the first regular weekly Bankers' acceptances...... _ 7 — 1 4- 29 — 43 — 22 auction in February, and the average issuing rates on the Federal agency obligations ...... — 50 + 17 4- 65 — 84 — 52 new three- and six-month bills fell to 6.95 percent and Member bank borrowings ...... — 223 + 155 4- 224 0 + 34 6.75 percent, respectively (see Table II), their lowest Seasonal borrowings! ...... + 1 o + 5 — 4 — 1 levels since May 1973. Together with the yield declines Other Federal Reserve a s s e ts t...... + 33 -f 100 — 593 — 501 registered at the preceding week’s auction, these decreases Total ...... — 87G + 525 4- 518 —1,163 — 996 brought the three- and six-month auction rates down more Excess reserves^ ...... — 135 + 195 195 4- 117 — 18 than 100 basis points from their levels of mid-January and more than 200 basis points below their peaks of Monthly Daily average levels averages! August 1973. Some profit taking emerged shortly after the auction, but the market firmed prior to the monthly sale of 52-week bills. This issue was auctioned at an average Member bank: rate of 6.34 percent, down 61 basis points from the Janu­ Total reserves, including vault c a s h !...... 35,475 35,367 35,393 34,885 35,280 ary issuing rate. Subsequently, the market softened in the Required reserves ...... 35,351 35,048 35,269 34,644 35,078 wake of Chairman Burns’s testimony before Congress which Excess reserves ...... 124 319 124 241 202 was interpreted as indicating that monetary policy would not Total borrowings...... 998 l, loo 1,377 1,ZOO 1,196 Seasonal borrowings! ...... ease significantly further. The auction on February 26 of 18 15 20 ID 17 Nonborrowed reserves ...... 34,477 34,214 34,016 00,001)gq flon $1.5 billion of tax anticipation bills due April 19, 1974 34,084 Net carry-over, excess or deficit (—) | | ___ 96 42 167 128 108 drew only routine bidding and the average issuing rate was set at 7.45 percent. With the rise of rates toward the end Note: Because of rounding, figures do not necessarily add to totals. * Includes changes in Treasury currency and cash, of February, the market yield on the three-month bill t Included in total member bank borrowings. closed the month only 2 basis points below its end-of- t Includes assets denominated in foreign currencies. § Average for four weeks ended February 27, 1974. January level and the yields on the six-month and 52-week II Not reflected in data above.

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bills closed 13 and 5 basis points, respectively, above their OTHER SECURITIES MARKETS end-of-January levels. Indications of an easing in money market conditions, the Yields on short-dated municipals declined in February. favorable terms of the refunding, and the drop in bill rates However, offerings of newly issued municipal and corpo­ prompted substantial declines in rates on intermediate- rate long-term debt met stiff investor resistance when un­ term Government securities during the early part of derwriters sought to attain lower rate levels, and long-term February. Yields on issues of more than ten years’ maturity rates changed little. Investors generally felt it prudent to moved only modestly lower, however. On Tuesday, Feb­ avoid lower yields at present, in anticipation of better ruary 5, the Treasury auctioned $1.5 billion of seven-year buys in the future. As a result, a number of aggressively 7 percent notes. Interest in this issue, part of the February priced issues failed to attract investor attention and a sub­ refunding package, was enthusiastic, and the average issu­ stantial buildup in dealer inventories developed. This ing rate was set at 6.95 percent. Interest in the 3 ^ -year backlog of issues in inventory gradually came to weigh 6% percent note offering the following day was somewhat heavily on the market and, as the month progressed, syn­ subdued. Nonetheless, the average issue price was above dicate price restrictions on a number of slow-moving is­ par, providing a yield of 6.70 percent. Following the auc­ sues were removed, resulting in considerable upward tion the tone of the market deteriorated somewhat in re­ adjustments in yields. sponse to Chairman Burns’s testimony, but the auction of The corporate bond market absorbed large volumes of $300 million of bonds due in August 1993, the final part of intermediate-term issues in February, as manifested by the the refinancing, attracted strong interest. The Treasury rapid sellout of three Aaa-rated bank holding company employed the technique of awarding all of the bonds at the price of the lowest accepted bid, and the yield to ma­ turity was set at 7.45 percent. Yields on Treasury coupon issues generally rose during the second half of the month. Yields on intermediate-term issues closed the month up Chart II about 4 to 9 basis points, while yields on issues due in ten CHANGES IN MONETARY AND CREDIT AGGREGATES Seasonally adjusted annual rates years or more ranged from 6 to 20 basis points higher. Percent Percent 1 ...... !5 The market for Federally sponsored credit agency se­ Ml From 13 v / \ weeks earlier _ curities benefited initially from the good tone of the Gov­ /"\ ernment securities market which prevailed early in the \ ' ------*/ J f month. About $2.3 billion in new agency securities was From 52 marketed in February. The early issues were well received weeks earlier at yields considerably below those on recent previous of­ 1 1 1 1 1 1 1 1 1 I 1 1 1 1 1 1 1 1 1 1 1 1 . 1 .1.. 15 ferings. At the beginning of the month, one of the farm 15 M2 10 ------10 credit agencies, the Federal Land Banks, marketed $389 X . ~ ; From 52 \ y \ million of 5Vi-year 7.15 percent bonds. Shortly thereafter, - 5 5j| weeks earlier From 13 Iweeks earlier 1 . . the Federal Home Loan Banks sold $300 million of ol 1 1 1 1 1 1 1 1 1 1 I 1 1 1 i i i i i 1 1 1 1 1 0 eighteen-month 6.80 percent bonds and $300 million of six- 20 20 ADJUSTED BANK CREDIT PROXY _ From 13 | / Y*weeks earlie r year 7.05 percent bonds. This offering represented a net 15 15 paydown of about $650 million of debt, and investor inter­ ---- - _10 est in these issues was strong. The paydown reflected the re­ 10 v V ^ From 52 5 duced dependence of savings and loan associations upon 5 weeks earlier / -

Federal Home Loan Bank advances as a source of funds o I 1 1 1 1 1 1 1 1 1 1 ii1ii1ii1ii 1 1lo now that rapid growth of savings deposits has resumed and 1972 1973 1974 Note: Growth rates are computed on the basis of four-week averages of daily mortgage demand has slackened. Later in the month, the figures for periods ended in the statement week plotted, 13 weeks earlier Export-Import Bank sold $400 million of five-year 7 per­ and 52 weeks earlier. The latest statement week plotted is February 20, 1974. Ml = Currency plus adjusted demand deposits held by the public. cent debentures priced to yield 6.95 percent. This issue did M2 = Ml plus commercial bank savings and time deposits held by the public, less negotiable certificates of deposit issued in denominations of $100,000 not encounter a good reception, and the underwriters cut or more. prices sharply in order to distribute the large unsold por­ Adjusted bank credit proxy = Total member bank deposits subject to reserve requirements plus nondeposit sources of funds, such as Euro dollar tion of the issue. A Federal National Mortgage Associa­ borrowings and the proceeds of commercial paper issued by bank holding companies or other affiliates. tion $1.2 billion issue met a mixed reception as optimism Source: Board of Governors of the Federal Reserve System. faded in the final week of the month.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF NEW YORK 79

note offerings. These bank note offerings represent part Table II of an extraordinarily large volume of bank issues sched­ AVERAGE ISSUING RATES uled to be marketed in 1974. The difficulty of marketing AT REGULAR TREASURY BILL AUCTIONS* In percent long-term debt at lower yields became apparent early in the month when $50 million of Aa-rated twenty-year util­ Weekly auction dates— February 1974 ity bonds met a poor reception when priced to yield 7.97 Maturity Feb. Feb. Feb. Feb. percent. This was about the same rate as that on an Aaa- 4 11 15 25 rated utility issue sold at the end of January. Investors were Three-month ...... 6.951 7.081 7.018 7.188 somewhat more enthusiastic about an offering of $70 million 6.747 6.882 6.787 7.081 of thirty-year utility bonds priced to yield 8.22 percent. Al­ though this issue was rated Aa by one rating agency and Monthly auction dates— December 1973-February 1974 only A by another, investors considered it comparable to Dec. Jan. Feb. the Aa-rated utility marketed earlier and bid more aggres­ 12 9 6 sively for it. Nonetheless, yields on both issues rose when Fifty-two weeks ...... 6.881 6.948 6.342 underwriters removed syndicate restrictions later in the month. Subsequent to these issues, market attention fo­ * Interest rates on bills are quoted in terms of a 360-day year, with the discounts from par as the return on the face amount of the bills payable at maturity. Bond yield cused upon a $300 million offering—the largest of the equivalents, related to the amount actually invested, would be slightly higher. year to date—of forty-year 8 percent debentures of a major Bell System subsidiary. As it turned out, the Aaa- rated issue attracted only moderate interest when priced to yield 8.06 percent, 1 basis point above the yield on an Aaa-rated Bell issue sold the month before. Further evi­ dence of the lack of interest in long-term issues material­ two Aaa-rated municipal offerings attracted only fair re­ ized later in the month, as $100 million of Aaa-rated ceptions. In the first, $59.6 million of bonds was priced thirty-year bank holding company debentures met a poor to yield from 3.75 percent in 1975 to 5.25 percent in reception when priced to yield 8.19 percent, despite the 1994. Subsequently, a $100 million issue, priced to return fine reception accorded the company’s note offering. from 3.75 percent in 1975 to 5.00 percent in 1994, was In the tax-exempt market, the major long-term issues marketed. Syndicate restrictions had to be removed from of the month also experienced relatively modest retail both issues for the offerings to sell out. Although short- demand. Early in the month, $168 million of A1-rated dated issues sold well, the Blue List of dealers’ advertised bonds sold slowly when offered to yield from 4.20 per­ inventories rose $108 million to $1,142 million by the cent in 1974 to 5.90 percent in 2015. Later in the month, end of the month.

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